Pension savings should yield more than just by how much the future inflation will depreciate money
From historical data over the past 110 years or so, it is clear that stocks, along with real estate, are the two main investment assets that generate significant positive real returns over the long term, i.e. returns that are higher than inflation. Why is this important? If I were to take a simple pension scheme – 20 years of saving, 20 years of pension payments, and investing only in assets whose returns only eliminate the depreciation of purchasing power due to inflation, this would mean that every crown I would like to spend on my pension would have to be saved now. Of course, the savings period can be longer, up to 40 years, and sometimes, unfortunately, the retirement period is even shorter, so theoretically it may be enough to postpone one crown for four future crowns in the case of a ratio of 40 years of savings - 10 years of pension, but this does not change the fact that if I want to postpone now less than the current value of the future real value of money in the variant of the same length of savings and pension, I have to help myself with assets that are capable of generating a real return.
Stocks are a much riskier asset than, for example, deposits or money market funds, and this also results in a high dispersion of annual returns. Even in the case of a widely diversified stock index, such as the S&P500 index, based on historical data, it can be expected that with a 95% probability the future annual return will range between minus 40% and plus 50%, which is a risk that not every investor is willing to take.
A long-term investment increases the chance to get a positive real yield from investment in shares
Stocks clearly belong in a long-term client portfolio – you can’t fight inflation without stocks! The chart below shows real annualized returns from US stocks and bonds in individual decades. It is clear that in the 1940s, 50s, 60s and 70s, bonds in the US had negative returns, if we subtract inflation from nominal returns. While stocks had a negative real return only in the 70s and in the decade after 2000. We are currently experiencing the 4th strongest decade in history for stocks despite high inflation (5.2% in the US is the average from 01/2021–08/2024). On the other hand, for bonds, this is the worst period yet in terms of real returns.
Timing of stock investments
The following chart confirms the claim that timing stock investments does not pay off in the long run - not being invested on the best days significantly reduces returns.
The graph shows that the benefits of investing in stocks are most evident in the case of long-term investments, such as pension savings, and it is for this type of savings that a conservative investor can afford to have a much larger share of stocks in his portfolio than would be the case, for example, in the case of medium-term investments.
Portfolio Manager Team
Erste Asset Management, Czech Republic
Long-term investment product – DIP
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How to prepare for the future and maintain a living standard even in retirement
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